Price to Earnings Ratio

The price to earnings ratio is the price of a stock or stock market index divided by past or future earnings (price to earnings ratio = Price / Earnings). For example, if the price of a stock is $20 per share and that particular company earned $2 per share over the past 12 months, then the trailing twelve month price to earnings ratio would be $20 / $2 or 10.

Many investors use the price to earnings ratio to determine if a stock or the stock market as a whole is expensive or not. For example, the average price to earnings ratio for the S&P 500 index from 1950-2000 was 15.4. When the market peaked in early 2000 the price to earnings ratio of the S&P 500 was a relatively high 30 suggesting that stocks were expensive.